Shorting VFC: Risk/Reward Good Here

Coming out of last week's meetings w/VFC and it’s competitors, we were not inspired by the story and it’s setup for 2011.  This matches up with Keith’s timing/sizing parameters as the stock is broken on both a TRADE and TREND basis.  VFC short timestamp = $83.44.

 

 

Here’s our sense on VFC over three different durations:

 

Long-term:  It’s hard for anyone to call VFC a bad company. This is not management’s first rodeo. They are pretty darn good at making the right business decisions to manage their portfolio, and then managing expectations accordingly.

The fact of the matter is that over the course of 10 years, VFC has…

  • transformed from a vertically owned/operated capital intensive commodity-based apparel company (ie…underwear, denim) to an outsourced and offshored  portfolio of lifestyle brands that carry significant weight the consumer (ie The North Face, Vans). 
  • printed a growth algorithm of 3-5% sales, 5-6% EBIT, and 9-10% EPS. When you layer on the fact that almost all of the incremental growth came from less capital intensive businesses, we see that RNOA went from 9% to 16% over that same period. That’s not half bad. In fact, it’s clearly above average relative to peers.

 

I’d argue that we’re at the point of the ROI decision tree where the business will slow organically at the same time we’re seeing severe cost inflation -- -and that’s exactly when VFC will step on the accelerator with acquisitions. We’re already modeling stock repo in our model, so we may have to redistribute the cash to above the line if a deal happens. We also will not give the company a free pass that any deal will be a good one. The industry is at peak margins right now, and valuations do not represent that. VFC knows how to vet a deal, and even they have had their share of disasters (7 for All Mankind). Also, let's not forget that this company's long-term transformation happened when the industry had the biggest milti-year tailwind that it experienced -- ever. 

  

 

Intermediate Term

  • Ultimately, with such a diverse portfolio of brands, consumers and channels of distribution, VFC is really a double edged sword. The mix protects them from some downside, but it precludes the company from fully capturing upside in the event of a rebound.
  • In the end, it’s hard to outperform the industry meaningfully when you ARE the industry. Unfortunately, 2011 will be a dark dark year for the apparel industry in the US. VFC may well be able to steer its pricing and inventories better than most, but the biggest risk is what they can’t predict – which is the irrational behavior on the part of competitors as margin is literally sucked out of the supply chain.
  • Bottom line – numbers need to come down for 2011. The Street is at $6.80 for next year vs. $6.30 in 2010. The $6.30 is very doable this year, but this company should consider itself lucky to earn that level again in 2011. Numbers are off by $0.50.

 

 

Short Term

  • 4Q10 is the last ‘easy quarter’ revenue and margin compares – which is largely due to growth in company retail (2x the usual revenue recognition) and strength in TNF.
  • This is going to come down to earnings catalysts.
  • Will VFC ‘lower the boom’? on its conference call in a few weeks? I think that there’s a 75% chance of some official guide down, and 25% chance of a BIG one (ie calling for a flat year).
  • Is it in the stock already? With an EBITDA multiple of 8.6x, my vote is No. RL is trading at the same multiple – but the difference is that the Street is LOW by 15% on RL.

 

Here are some cliff notes from our meetings w VFC at last week’s conference. Some is relevant, some is not. Take it for what it’s worth.

 

VFC:

o “We want to own your closet, the whole closet. And, maybe some drawers and shelves as well”

o More than double north face to $3 bil. ‐5 yrs

o Mid march investor day will layout 5 year plans

o International EBIT 200 bps higher than total corp op margin. Lower tax rate abroad helps EPS. Will be 40% of

total in 5 years.

o China $1 bln opportunity

o No single brand fully developed on retail. Vans largest. 67 TNF, grows to 190 globally 5 years

o GM’s will continue to expand in same manner as prior 5 years.

o Spent incremental $100 mm on sg&A in 2010 centered on marketing. Half on tnf and vans.

o 5.6% of total (mktg) was, 5% historically. Will be lower in 2011, to offset margin pressure

o Cash flow: exceed $900 mm, was $850. Acquisitions top priority.

o Focus on outdoor, action sports

o 5mm repurchase in 2010, vs. historical rate of 1‐2mm shares per year.

o May see north of 80 new stores in 2011, incremental comes from international

o Will cut incremental marketing spend from ’10 to offset cost pressures

o Not yet locked in on denim for Fall. Many denim mills still not accepting orders and holding out for more clarity.

o Bought some denim textiles in late ’10, will show up in YE inventories. Small but will help to offset costs.

o Rock and Republic (if successfully closed with courts) will be positioned away from competing with Seven. Likely

goes downstream from super premium.

o All brands taking price, but not all due to cotton.

o Feb 1st will see price increases in denim at retail, at WMT

o Low‐end denim price increase will not fully offset costs

o Expect 10‐15% more cotton to be planted, which may result in substantial price relief by year end.


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